Insider loans rife as bank collapsed

BREMERTON — Westsound Bank was hailed nationally as an “all-star” for its wild growth during the real-estate bubble.

But it was, in many ways, Washington’s worst community bank — one of a handful of failed banks nationwide whose leaders the Federal Deposit Insurance Corp. (FDIC) sued to recover damages it attributes, in part, to a pattern of illegal insider lending.

Millions of dollars were loaned on cozy and potentially illegal terms to some of the bank’s directors and its top lending executive. Scores of millions more went out the door in speculative real-estate loans, including million-dollar loans to Russian amateur homebuilders recruited by a man now wanted for bank fraud and money laundering.

The FDIC settled a civil lawsuit against the bank’s former executives and directors in November for only $1.7 million, with the defendants not admitting any wrongdoing. Their insurer paid the settlement and their legal fees. Today, some former executives still work for banks or mortgage companies.

But a Seattle Times investigation of insider dealing at Westsound shows the FDIC lawsuit only scratched the surface. The bank offers a prime example of the potential for abuse by those running a small community bank — particularly when regulators rely on a bank’s own management to disclose any insider transactions.

“There is a high correlation between bank failure and lending to insiders,” said Cornelius Hurley, director of Boston University’s Center for Law, Finance & Policy.

Deals with insiders, he said, show whether “they treat it as an institution with certain responsibilities or whether they treat it as their own private piggy bank.”

Generous loans to executive’s partners

When regulators shut down Westsound in May 2009, they pegged the failure’s cost to the FDIC at more than $100 million — almost one out of every two dollars the bank had in total loans.

The loans to insiders didn’t single-handedly sink the bank, but those loans reflected a corporate culture obsessed with growth at any cost.

The biggest beneficiaries of Westsound’s generous insider lending were its chairman, Louis Weir, and its top lending executive, Brett Green. Collectively, they and their enterprises received at least $9.9 million in real-estate loans from 2002 to 2007, records show.

During Green’s tenure at Westsound, he and his outside real-estate enterprises received at least $5.4 million in loans from the bank, public records show. And his business partners benefitted from at least $8 million in additional loans either to them or their companies, records show.

The Times’ investigation also found that Weir and Green, through two real-estate partnerships, repeatedly borrowed money from Westsound to buy land, subdivided it and sold lots to builders for speculative projects financed with more Westsound loans.

They made big profits. But the bank sometimes lost money.

Westsound’s insider lending peaked at the end of 2006, at 3.1 percent of total loans — compared with 1.8 percent for all banks nationally, federal data show.

“It’s a big red flag when you approve insider loans and those loans are questioned as to their legality,” said David Baris, executive director of the American Association of Bank Directors. “If (regulators) see that, they also suspect everything else.”

The FDIC, the Federal Reserve and the Westsound insiders all declined to comment for this story.

Insider abuse

Bank officers and directors are allowed to borrow money from the institution they oversee — so long as they follow the rules and don’t gain at the bank’s expense by abusing their power.

Nobody knows how prevalent insider abuse was in the recent wave of more than 460 bank failures. But a federal study of 286 earlier bank failures found insider problems in more than half; it was the major cause of failure in about a quarter.

Since a banking scandal in the late 1970s, a federal law called Regulation O obligates banks to report lending to insiders and businesses they control.

The law prohibits preferential or high-risk loans, and requires a bank’s board to approve large loans before the bank commits to them. Violators can be fined as much as $1.1 million per day.

Only a bank and regulators are privy to the details of those loans, however. What little visibility the public had into such deals was eliminated in 2006, when President George W. Bush signed a law repealing a 1983 requirement that banks disclose the number and total amount of loans to executive officers and major shareholders, as well as the approximate interest rates.

“You have absolutely no idea because there’s no details and no transparency. It’s bad for the shareholders. It’s bad for the depositors.”

Ambitious for growth

Westsound Bank was organized in 1998 as a state-chartered bank by a group of local businessmen led by Klaus Golombek, a banker who had started and sold a previous bank, National Bank of Bremerton.

Golombek wanted Westsound Bank to carry on the slow and steady growth that made Bank of Bremerton successful. But he left after clashing with the board — especially its chairman, Weir, a major local real-estate investor known for starting a chain of appliance and electronics stores in the area.

“They wanted to be the fastest-growing bank in the state of Washington, and that’s when we parted ways,” said Golombek, who’s now retired.

That left Westsound’s board with only one person experienced in banking. The rest worked mostly in real estate and construction.

In 2001, the board hired 36-year-old David Johnson, a Colorado banker, as Westsound’s CEO.

To lead Westsound’s new mortgage division, Johnson recruited Brett Green, an experienced mortgage banker and real-estate investor. Green also was bank chairman Weir’s partner in Weir Green, which acquired land for development.

Less than four years later, in early 2005, regulators discovered that Westsound’s extensive loans to Green and his ventures violated lending limits to bank officers under state law. (Story continues below interactive)

Interactive: The bank insiders and their deals

In a lawsuit filed in 2011, the FDIC alleged top insiders at Bremerton-based Westsound Bank received loans that violated federal laws on sweetheart deals for directors, officers and their businesses. The case was settled in November for $1.7 million, with the directors and officers admitting no wrongdoing.

Click on the people or companies below to see who was connected to which deal.

Insider loans at Westsound Bank

Sources: FDIC, Seattle Times staff research

In Washington, without prior board approval, a state-chartered bank’s total outstanding loans to an officer cannot exceed $500,000.

Johnson invoked a state rule that allows state-chartered banks to be treated as federally chartered, with a higher limit for such loans. With a stroke of Johnson’s pen, that brought the existing loans to Green back within legal limits, setting the stage for more insider loans.

Loans called illegal

Westsound, the FDIC alleged in its lawsuit, made “numerous” loans to insiders that were illegal for three reasons:

• The loans were at below-market interest rates and on terms not available to the public. Some were made at 2.25 percentage points below the bank’s “base” rate — the rate it would charge its best customers.

• The borrowers owed Westsound more than $500,000 when they received more credit without prior approval by the full board.

• The borrowers got loans with weak collateral and without normal underwriting. The bank’s own credit analysts were blocked from reviewing directors’ financial statements.

The defendants “acted in their own self-interest at the expense of the bank,” alleged the FDIC, which described seven illegal insider loans that cost it at least $1.7 million.

The biggest of these allegedly illegal loans was a $1.25 million loan to a company owned by director Dean Reynolds, who chaired Westsound’s loan-approval committee.

The bank made the three-year loan to Reynolds’ metal-coatings company, TTIC, at an interest rate below the prime rate, even though Reynolds “hadn’t demonstrated an ability to repay” a previous loan, the FDIC alleged. The collateral also was “inadequate” — less than one-third the loan amount.

Johnson, Green, Weir and one other director on the bank’s loan committee approved that loan in May 2007, the FDIC alleged.

Weir and Green had an apparent conflict of interest, The Times found: They were co-managers with Reynolds in a Jefferson County real-estate venture called Teal Lake Center, corporate records show.

The next month, Reynolds and another director approved a $500,000 prime-rate loan to Weir Green — another loan the FDIC alleged was illegal. That loan was to buy out a partner in Olympic Development, another real-estate venture that Weir and Green already owned half of.

At the time, Weir, Green and their various companies had other unpaid loans from Westsound, “all of which had been repeatedly extended,” the FDIC alleged. Among them was a $290,000 loan in May 2005 that wasn’t even reported by the bank to regulators that quarter or the next, records show.

Westsound’s full board gave its blessing to the $1.25 million loan to Reynolds’ company and the $500,000 loan to Weir Green in July 2007 — but that was largely symbolic, the FDIC said, because contrary to the law, the bank had already granted the loans.

Whether the insider loans cited by the FDIC were indeed illegal was never put before the court because the suit was settled before trial.

As of mid-2007, the bank publicly reported total insider loans of about $8.6 million.

But that didn’t count a whole other level of insider dealing — loans to Green’s business partners or to builders buying land from the two men’s real-estate partnerships.

Insider loans, outsized profits

In the first three months of 2007, Westsound loaned builders millions of dollars to buy lots from Olympic Development, the company half-owned by Weir, the bank’s chairman, and Green, its executive vice president of sales and lending, The Times found.

For example, the partnership had bought land in Port Orchard the previous year for $315,000, putting down about 20 percent and obtaining a loan from Westsound for the rest, records show.

Then in January 2007, Olympic Development sold the land, a subdivision called Harris Place, to a Tacoma contractor for $775,000 — more than 10 times the partnership’s initial cash investment.

Olympic Development closed an even more profitable deal two months later.

The partnership sold lots in a Port Orchard subdivision known as Indigo Point for more than $1.8 million to Grice Corp., an excavating company run by Standford Grice. Westsound loaned Grice more than $2.6 million with the lots as collateral, records show.

The land hadn’t cost Olympic anything: It was given as a “gift” to the venture in April 2004 by James Corp., which bought it four months earlier, financed fully by a $215,000 Westsound loan.

James Corp.’s owner, Jim James, became a partner with Weir and Green in Olympic Development. And his company went on to receive millions of dollars in Westsound loans for land development and construction, records show.

As for Grice, after receiving his Westsound loans to buy lots from Olympic Development, he struggled to finish selling all of his lots and defaulted, owing the bank about $377,000.

Bad loans to builders

Westsound’s loan committee kept granting construction and development loans to Green’s ventures and business partners — and to others — even after regulators’ repeated warnings in 2006 and 2007 to set limits on total loans for land acquisition, development and construction.

These higher-risk “ADC” loans, especially for homebuilding, had multiplied sixfold from 2004 to 2007, propelling the bank’s explosive growth.

Starting in February 2006, examiners criticized the bank for failing to set any limits on risk in its loan portfolio and for not adhering to its existing limits on land loans. They singled out the bank’s high concentration of credit in ADC loans: Westsound already ranked higher than 98 percent of its peer banks nationwide in its exposure.

At the next examination in February 2007, regulators again scolded Westsound’s board and management for making big loans to builders with little or no equity, scant effort to verify the borrowers’ ability to repay the loans, and inflated appraisals based not on properties’ current value but on the “as completed” value of projects that largely existed on paper, the FDIC alleged.

Insiders weren’t the only beneficiaries. One of the worst such transactions cited by the FDIC was a $1.5 million loan made in 2006 to Ginger Perkins, a grocery-store clerk.

The loan was to buy three duplexes and convert them into homes.

“Borrower is betting on the market continuing to increase over the next year,” the loan memo stated. Green, Weir, Reynolds and another director approved the loan.

The FDIC alleged Perkins had no experience with this kind of project, had meager income and assets, and put hardly any money down. The collateral’s value was based purely on an appraisal of the building plans “as completed.”

Said Jerry Becker, a longtime homebuilder and Westsound borrower: “Anyone who decided they wanted to build a house got a loan.”

By the end of 2007, about 60 percent of the bank’s loans were tied to construction and land development, ranking Westsound ahead of 99 percent of its peers nationwide.

Partners in business

Green’s stakes in at least seven real-estate ventures weren’t disclosed in an annual report Johnson filed in January 2007 to the Federal Reserve on behalf of the bank’s holding company.

Meanwhile, there was a web of other loans to Green’s business partners in these ventures that the bank wasn’t even required to report, The Times investigation found.

Green’s partner in Robison Green received more than $2.9 million in Westsound loans from 2004 to 2007, records show, while that partnership obtained about $1.1 million in loans.

An excavating contractor, a partner with Green in TGR Investments, received about $475,000.

Another builder who partnered with Green in Twin Spits View — a speculative venture to develop 20 acres in north Kitsap County — got at least $736,000.

The FDIC declined to comment on whether it was aware of those loans or reviewed them. Its lawsuit mentions only five companies disclosed to the Federal Reserve by the bank’s holding company.

And the FDIC says it’s limited generally in which insider loans it can pursue in court — only those that both are in default and have been approved within three years prior to a bank’s failure.

The Fed had no comment on the holding company’s failure to disclose Green’s role in other businesses.

Green and most of the bank’s mortgage division were terminated from Westsound in September 2007, a month after state and federal investigators uncovered a whole other set of problems at Westsound: evidence of fraud in the bank’s mortgage lending to inexperienced Russian and Ukrainian homebuilders recruited by a man who was receiving kickbacks on every loan, federal prosecutors say.

Who’s accountable?

Westsound ultimately failed because its board and management did not heed regulators’ instructions to limit and clean up its outsized portfolio of construction and development loans, according to an FDICinspector general’s report, which made no mention of the insider loans.

The FDIC lawsuit, likewise, complained that the bank’s leadership — Johnson, Green, Weir and others — simply ignored “multiple and repeated warnings” about a host of deficiencies, including insider loans.

But state and federal regulators haven’t explained why they didn’t rein in Westsound’s activities, starting with curbing the bank’s extensive insider loans to its chairman and top lending executive. The regulators say they don’t comment on their supervision of a bank, even a failed one.

Today, many of the bank’s key executives still work in financial services.

Johnson, who left his CEO job in 2008, filed for bankruptcy and now works in Colorado for a bank. In a response to the FDIC’s allegations, Johnson denied in a court filing that the insider loans violated Regulation O. He declined to comment for this story.

Green, the former top lending executive who was let go in 2007, runs the Silverdale branch of a national mortgage company. Green asked the court to dismiss the FDIC’s claim against him, saying the board, not he, was responsible for approving insider loans. He declined an interview request, saying, “I’m not interested at all.”

Weir, the former chairman, still manages his real-estate investments. He hung up on a reporter seeking comment.

Don Cox, a CPA who joined Westsound’s board in January 2007 and was its chairman when regulators closed the bank, said most directors who serve on the boards of small banks don’t have the expertise to read a financial statement, let alone supervise a bank’s lending.

“The average director has no clue what’s going on,” Cox said. “The directors are all absolutely at the mercy of management.”